Will Cell C sink Blue Label?

A tenfold increase in losses hasn’t deterred Cell C’s executives from talking up a turnaround.

After weeks of prevarication, Cell C, which is 45% owned by listed group Blue Label Telecoms, finally released its results for the year ended May last week.

"Below expectations", as CFO Zafar Mahomed described the numbers, hardly does justice to an R8bn loss.

After all, Cell C has about 17-million subscribers, who spent 4% more over the period, taking revenue to R14.2bn.

While the R8bn loss is almost entirely due to a R6.27bn impairment, earnings before deductions fell 19% to R3.39bn.

Speaking at the presentation, held at Blue’s headquarters, CEO Douglas Craigie Stevenson said Cell C’s performance in the months after May showed evidence that a turnaround plan is bearing fruit.

The operator has grown sales by 2% year on year over June, July and August, with earnings before interest, tax, depreciation and amortisation rising 18%, to R1.042bn.

Still, this growth story is a hard sell. Peter Takaendesa, portfolio manager at Mergence Investment Managers, is not convinced of the recovery line.

He says the quarterly results show some improvement, but with a slowdown in service revenue growth, this looks to be largely related to cost cuts.

Then there’s Cell C’s mountainous debt, which has consistently threatened to sink the mobile operator.

It owes R8.24bn to a number of lenders and recently defaulted on its interest payments, prompting S&P Global Ratings to downgrade its debt to D, or "default" — the lowest-possible junk rating.

"It’s unsustainable," says Mahomed, adding that talks with lenders are ongoing.

"Our negotiations with lenders are premised on the fact that we can perform as a company, which is why we focused on showing the last three months’ performance, to show what it is we can do, and that builds a lot of credibility," he says.

Craigie Stevenson chimes in, saying all their efforts now are to build confidence and show that Cell C’s debt "is not a runaway train".

"Zaf and I have been very strong in our view about what needs to take place in the business, and it’s coming out now in the numbers. I still maintain that it has not been a very well-run business, and certainly not a performance culture, and that’s what is required to compete in this market."

Craigie Stevenson and Mahomed are at pains to talk up the last quarter’s performance: "You have to show a positive trend in the numbers. If you have a look at what we’ve done in the last quarter, that’s telling you that we’re starting to move this thing in the right direction and we’ll continue on that trajectory."

But given that Cell C has, with the exception of a few rare years, been loss-making since its launch in 2001, investors could be forgiven more than a little scepticism.

Cell C’s turnaround strategy is premised on four elements: managing liquidity; increasing operational efficiency; a new network strategy; and recapitalising the business.

"What we’re doing is not rocket science," says Mahomed.

Well, no, though there are other options.

Strategy Worx CEO Steven Ambrose sees a future for Cell C, but says it should sell its physical cellphone towers, enter into agreements with big players like MTN to use their network infrastructure and compete purely on mobile services by creating attractive data and voice packages.

Cell C already uses MTN’s network in areas where it does not have coverage. It previously roamed on Vodacom’s network but switched to MTN in late 2018, an agreement that was expanded in August.

Mobile operations are capital intensive and require large scale to be profitable, Ambrose says. The problem is that Cell C doesn’t have deep enough pockets to keep everything running as is. Operationally, it has to streamline, cut costs and become more efficient, he adds.

"If you took Telkom Mobile out of Telkom, and let it run on its own, it would never make it. It doesn’t have enough subscribers. The capital costs, the overheads — they could just not do it. And that is exactly the problem that Cell has got," says Ambrose.

Cell C’s management appears to agree.

"The third and fourth operators are never going to compete on capital expenditure," says Mahomed. "Even if we were to spend R10bn a year for the next 10 years, we won’t catch up."

He uses the analogy of a motorway: "Why would you have multiple highways for the same road to Durban, where you can have multiple lanes?"

It’s not just Mahomed and Craigie Stevenson who are under pressure to pull off a turnaround and win over the sceptics, however.

Blue Label, which owns 45% of Cell C, slumped to a R6.6bn loss for the year ended May, thanks to trading losses and its decision to write off its Cell C investment entirely.

To put it in context, that’s bigger than Blue’s market capitalisation of R2.7bn, which has collapsed about 45% in value this year alone.

That’s almost entirely due to Cell C.

When Blue first announced its intention to buy into the operator, in December 2015, its shares were trading at around R10.

They peaked at R21 in October 2016 and when the deal was finally completed in August 2017, had settled at around R15. At that stage, Blue’s cash injection of R5.5bn helped Cell C bring its debt to just under R6bn.

Co-CEO Brett Levy says: "Obviously we have investors that are not happy with us. They’ve seen destruction in the share price … and it’s important for us as management at Blue Label to gain the respect of the market again and gain trust."

Blue Label has always maintained that it’s not staking the farm on Cell C.

Says Levy: "The greatest concern of all, without doubt, is: does Cell C sink Blue Label? I think we’ve now definitely taken that fear away entirely to show that we are two separate businesses and that, actually, Blue Label is doing well."

The problem is that Blue has now been forced into some asset sales in order to reduce its Cell C-related debt.

It’s selling 3G Mobile, for example — a company for which it paid R1.9bn only two years ago — for R544m.

It’s not without problems in other areas of the business, either: Blue also impaired its investment in payment services company Oxigen India Services, which lost R86.6m over the year.

Stripping out the impairments and trading losses from joint ventures, its original business of airtime and prepaid electricity distribution grew core headline earnings by 26% to R904m.

Just One Lap’s Simon Brown says: "Blue Label was a good little company doing its great little business, plugging along. They thought they could get clever and now they’re paying the price for it."

Takaendesa says Cell C can still wreak major damage: "I think the sooner they reduce their exposure the better. There is potential for value unlock if they can materially reduce their direct exposure to Cell C."

The fallout at Cell C has also swept up Net1, which paid R2bn for its 15% stake in Cell C in 2017.

But Ambrose is more upbeat.

"The accounting treatment and the operations are totally different," he says. "They’ve had to write off their investment in Cell C to nil because effectively without Blue Label’s guarantees, and with everything going on at an accounting level, Cell C is technically insolvent. That doesn’t mean that it’s operationally insolvent."

Ambrose believes that Cell C has enough cash flow to keep going "for the medium term".

Still, it all hinges on a recapitalisation, and detail there is as skinny as its profits.

While Cell C signed a binding agreement with the Buffet Consortium, led by reclusive billionaire Jonathan Beare, in February to come on board as a minority shareholder, a formal deal remains elusive.

When asked whether the consortium has been scared away, Mahomed simply says: "The answer is no."

That said, there is some debate among analysts as to how a deal will be structured. The consortium could take an equity or debt position in Cell C.

And Brown says it’s possible that Beare could opt for preference shares.

"He’s not someone who’s going to throw money at it [Cell C]. He didn’t get rich by taking risks, he’s very crafty in that sense. So something like preference shares or debentures, which puts him ahead of normal shareholders, works."

In other words, Beare and the Buffet group would have preference over shareholders like Net1.

Brown adds: "In theory, it’s better for existing shareholders because it doesn’t dilute their stakes in the company."

Ultimately, however, would-be white knights are unlikely to extend any cash to Cell C in its current form.